Foreign Earned income exclusion for expats

The 1st method is called Bonafide Residence Test (BFR). This is a qualitative test, meaning you need to be a bona-fide( good faith) resident of that country, tax home must be in that country, place of work, bank accounts etc. must be in that country for an uninterrupted period that includes an entire tax year (January 1–December 31, if you file a calendar year return). In the initial year of departure, you will have to satisfy the above test by being a resident of that country, the following year to claim BFR. Say that your assignment starts in september 2021, for the tax year 2021, you will have to be a resident in the assignment country for the entire 2022. Your 2021 Tax return will only be filed in January of 2023! Form 2350 needs to be filed for seeking extension of time due to form 2555 – Foreign earned income exclusion. This method is usually applicable to long term assignments of the Taxpayer which usually last more than 12 months.

If your spouse is working abroad as well and has foreign earned income and meets the above criteria, would be eligible for their own separate “ earned income exclusion”. Assuming both are staying in the same foreign home, housing exclusion can be taken by the taxpayer who’s Foreign earned income is higher. The exclusion can also be considered for self-employment income as well.

The second method is called the Physical Presence Test. This is a quantitative test, where a US Citizen or a resident must live in foreign country for at least 330 days (non-consecutive) over a 365 day period. The 330 full days can be interrupted by periods when you are traveling over international waters or are otherwise not in a foreign country. Assuming a 365 day annual year, a taxpayer can be in the US for a maximum of 35 days in a year to meet the test. Also once 330 foreign days(non-consecutive) conditions are met, then any of the 35 days allowed for US days that are remaining can be rolled back from the beginning of the assignment or the ending of the assignment, thereby extending the qualifying day period,also known as “slide days”. Usually Green card holders follow the PPT method as a safe approach as Green card holders can only be a resident of one country at time! Assuming, if there is a Tax treaty from the taxpayers country of birth/origin/ citizen with the United States, non discrimination clause, if given in the tax treaty can be used to claim BFR in those instances. This is a very aggressive position which may get a scrutiny check from the IRS.

Also, the choice to claim FEIE is of the Taxpayer, on whether to claim or not to claim. Else, it may also be beneficial to go with Foreign Tax credits, if the taxpayer is on assignment to a high tax country. Once the taxpayer does decide to claim the exclusion, the taxpayer has effectively elected to claim the exclusions in all future years that the taxpayer qualifies to claim. The taxpayer can also revoke the election, however might not claim again for 5 years, unless it has special permission from the IRS. The foreign assignment country can change during the year or during the duration of claiming this exclusion. The taxpayer can have back to back assignments in Foreign country without breaking these tests.